Dividends vs. Treasury Yields in Retirement Accounts

by: Avi Morris

Treasuries and similar fixed income investments are popular investments in retirement accounts. While they provide low yields, especially in recent years, their major attraction is the they are considered to be free of risk.

Of course, now risk free considerations are being put to the test with the debate about raising the debt ceiling. Chances are the government will not allow a default, but the AAA credit rating is at risk and probably will remain a concern even when this crisis is resolved. S&P gives a 50% chance for a rating downgrade. Currently 10-year Treasury bonds yield 2.98% and the 2-year notes yield a measly 44 basis points (which has increased recently). Gold is the only investment free of the business risk but it does not provide a yield. It has been getting more respect because of its safe haven quality and has a 10 year streak of higher prices, reaching a new record of $1,617 an ounce.

Stocks are considered the main alternative to the above. Many offer attractive dividend yields, important in providing investment growth. Stocks with middle yields (2½-3½%) deserve more attention, especially Dividend Aristocrats which have increased dividends for a minimum of 25 consecutive years. Their yields are comparable to the yield on 10-year Treasuries and offer the expectation of rising dividends over time. Long term track records of increasing dividends are more impressive when remembered that they were maintained through a difficult recessionary period 10 years ago and the 2008 financial crisis which negatively impacted many of the biggest industrial companies.

Below is a list of Dividend Aristocrats with moderate yields and P/E ratios. Note RPM is not an S&P 500 company (because of its $3 billion in market cap):

P/E Yield
RPM (NYSE:RPM) 16X 3.9%
Abbott Labs (NYSE:ABT) 12X 3.7%
Johnson & Johnson (NYSE:JNJ) 13X 3.5%
Procter & Gamble (NYSE:PG) 16X 3.4%
Pepsico (NYSE:PEP) 15X 3.2%
Bemis (NYSE:BMS) 16X 2.9%
McDonald's (NYSE:MCD) 18X 2.8%
Automatic Data Proc (NASDAQ:ADP) 21X 2.7%
Emerson Electric (NYSE:EMR) 17X 2.7%
PPG Industries (NYSE:PPG) 13X 2.7%

Moderate yields typically indicate the business risk of lowering dividends or ending the streak of raising annual dividends is minimal. The financial crisis in 2008 tested financial strength of stocks. These survived and extended their streaks of raising dividends. Attractive yields, growing dividends and capital appreciation allow funds to grow for future needs. Growth in retirement funds has gained importance in modern times because retirees are living longer with more active lives. Many expect to live 20-30 years (or more) during retirement.

The debt crisis highlights the need to reexamine investing in Treasuries. The threat of Treasuries losing the AAA rating adds a new risk to these investments. With more risk, investors can demand higher returns (lower bond pries) to compensate for higher risk. Stocks will continue to have higher volatility. Yesterday EMR fell $3.62, an unusually large daily loss for a Dividend Aristocrat, because of the threat that an economic slowdown would severely impact EMR. That happened two years ago, but the company persevered and continued raising the annual dividend as it has been doing for more than half a century. These stocks have track records of rewarding stockholders with higher dividends which should lead to higher stock prices.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.